Plaza mem­o­ries may un­nerve Trump-fu­eled US dol­lar bulls Mar­kets draw par­al­lels be­tween Trump and Rea­gan

Kuwait Times - - BUSINESS -

Par­al­lels be­tween Donald Trump’s US eco­nomic plan and early 1980s Reaganomics have su­per­charged the dol­lar, re­mind­ing some that its ram­pant gains 30 years ago even­tu­ally re­quired in­ter­ven­tion to re­verse them. The green­back’s surge un­der then-pres­i­dent Ron­ald Rea­gan was so pow­er­ful that by 1985 it re­quired a rare in­ter­na­tional ac­cord be­tween the world’s five lead­ing eco­nomic pow­ers and their cen­tral banks to weaken the cur­rency - the so-called Plaza Ac­cord, named af­ter the New York ho­tel where the deal was inked.

Trump - who purely co­in­ci­dently owned the Plaza for a while af­ter the ac­cord - has pledged a $1 tril­lion fis­cal pack­age of tax cuts and in­fra­struc­ture spend­ing over 10 years. This fol­lows a path set by Rea­gan in the early 1980s and mar­kets are tak­ing their cue. The rise in US bond yields and ex­pected path for in­ter­est rates based on growth prospects has boosted the dol­lar’s five-year rally, lift­ing the cur­rency to a 14-year high. Most ob­servers ex­pect it to ap­pre­ci­ate next year as the US econ­omy out­per­forms and the Fed­eral Re­serve raises rates while other ma­jor economies and cen­tral banks lag be­hind.

But the dol­lar can only rise so much with­out harm­ing US man­u­fac­tur­ing, a sec­tor Trump has promised to sup­port. Mem­o­ries linger of the three mil­lion man­u­fac­tur­ing jobs lost in the early 1980s un­der Rea­gan be­fore the his­toric agree­ment in 1985 be­tween the Group of Five lead­ing economies to bring the dol­lar down. Nigel Law­son, Bri­tish finance min­is­ter in 1985 and a sig­na­tory of the Plaza Ac­cord, notes that the drive to weaken the dol­lar then was led by Wash­ing­ton. “The Plaza agree­ment was a US ini­tia­tive,” Law­son told Reuters in an email. “In present cir­cum­stances, that seems un­likely to oc­cur.”

Jim O’Neill, for­mer chief econ­o­mist at Gold­man Sachs who was cut­ting his teeth in cur­rency mar­kets in New York at the time of the ac­cord, agrees that no ac­tion will be taken yet. But his­tory shows that dol­lar ap­pre­ci­a­tion al­ways ends up be­ing met with re­sis­tance from Wash­ing­ton. “Dol­lar ex­pan­sions usu­ally end when US pol­i­cy­mak­ers stop them and say ‘enough is enough’,” O’Neill said. “It’s in­evitable that Wash­ing­ton curbs the dol­lar rally at some point. It’s il­log­i­cal that the US can tol­er­ate a sharp rise in the trade-weighted dol­lar.”

Not the same

While there are par­al­lels to­day with the early 1980s, there are also huge dif­fer­ences. When Rea­gan en­tered the White House in 1981 the US cur­rent ac­count was broadly bal­anced. But the dol­lar’s surge and debt-driven con­sumer boom blew it out to a deficit of around 3 per­cent of gross do­mes­tic prod­uct by Plaza. The deficit to­day is just over 2 per­cent of GDP com­pared with a record 6 per­cent a decade ago, but could start to widen again if a Trump boom emerges to widen the US growth and yield gap with the rest of the de­vel­oped world.

An­other dif­fer­ence is the level of US in­ter­est rates and in­fla­tion. Back then, Fed chief Paul Vol­cker crushed 15 per­cent in­fla­tion by vir­tu­ally dou­bling in­ter­est rates to 18 per­cent in 1981. US in­fla­tion and rates may be mov­ing higher again, but from his­tor­i­cally low lev­els. They pale against Vol­cker/Rea­gan era, even if the path for US pol­icy and the dol­lar ap­pears to be di­verg­ing widely with Europe and Ja­pan.

Then there’s emerg­ing mar­kets, and China in par­tic­u­lar. Emerg­ing mar­kets now ac­count for more than half global eco­nomic out­put and have stock­piled tril­lions of dol­lars of for­eign ex­change re­serves, much of that banked in US bonds. The elec­tronic flow of cap­i­tal across bor­ders has never been greater or faster. Thirty five years ago their pres­ence on the global eco­nomic and fi­nan­cial stage was neg­li­gi­ble. China’s weight­ing in the trade-weighted dol­lar in 1981 was less than 1.5 per­cent. To­day, it is al­most 22 per­cent. China is now the world’s sec­ond big­gest econ­omy, the largest in­ter­na­tional cred­i­tor to the United States, and dol­lar-de­nom­i­nated bor­row­ing in emerg­ing mar­kets runs into the tril­lions of dol­lars.

The stock of dol­lar-de­nom­i­nated debt of non-banks out­side the United States cur­rently stands at just un­der $10 tril­lion, of which $3.3 tril­lion is in emerg­ing mar­kets, ac­cord­ing to the Bank for In­ter­na­tional Set­tle­ments. This world­wide vul­ner­a­bil­ity to a ram­pantly strong dol­lar could serve as an au­to­matic sta­bi­lizer be­cause it is in ev­ery­one’s in­ter­est to keep it for overly strength­en­ing. Steve Bar­row, head of G10 strat­egy at Stan­dard Bank and who also cut his teeth in fi­nan­cial mar­kets at the time of Plaza, reck­ons the dol­lar’s “im­pul­sive” rally could go an­other 10 per­cent be­fore be­ing cor­rected by the mar­ket. “Plaza came af­ter the dol­lar had turned. Cen­tral banks came in to re­in­force it,” Bar­row said. —Reuters

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